Written By: Michael Joyce
Lawmakers in Puerto Rico are wrangling over a tax reform bill while the April 30 deadline for an agreement between the Puerto Rico Power Authority, bondholders and banks approaches. Meanwhile, prices on longer-term bonds issued by entities in Puerto Rico continue a recent slide. With about two months left in Puerto Rico’s fiscal year, a budget bill has to be passed to pave the way for a $2.9 billion bond sale that will ease a cash crunch for the commonwealth. The rating firm Standard & Poors added to the stress this week by lowering bond ratings across the board for all debt in Puerto Rico.
It should be noted that the shorter-term Puerto Rico bonds that our clients own have been little impacted by the recent developments there. This probably reflects that investors are banking on a broad Puerto Rico restructuring. The Power Authority Revenue bonds will be most impacted by action (or inaction) on the April 30 deadline mentioned above, but the tax reform bill and budget enactment by June 30 will be critical to other credits in Puerto Rico. Also, keep in mind that when a credit is downgraded, the rating agency is downgrading all of the bonds of the issuer. Most issuers in Puerto Rico have some bonds that will mature in over 30 years. Yet these long-term bonds will be rated the same as short-term bonds.
The interest on bonds issued by entities in Puerto Rico is exempt from U.S. federal and state income taxes.
An interesting tidbit from Bloomberg this morning is that the yields on Puerto Rico General Obligation bonds due in 2035, the most frequently traded bonds in Puerto Rico (although not owned by any of our clients), are trading at a tax equivalent yield of 17% for those investors in the highest federal tax bracket. That compares with an 8.2% yield on Argentina’s benchmark dollar bonds which have been in default since July.
The distress in Puerto Rico bonds has been noticed by others. Noted bond investor Jeffrey Gundlach of DoubleLine Capital has more than doubled holdings in Puerto Rican bonds in his Income Solutions Fund to $45 million since the beginning of the year. A group of 34 hedge funds (including Davidson Kempner, a holding in MJA Special Opportunities Fund, LP) have also increased holdings in Puerto Rican bonds to $4.5 billion based on a potential turnaround.
We will be keeping an eye on developments in Puerto Rico.